Market Correction Still in Progress

by Krishna on March 5, 2009

Once again raising the specter of a great Depression, the stock markets today are at fresh 12-year lows. Citigroup shares at less than a dollar and nationalization (by whatever term it will be called) imminent. To rephrase a tired joke, you could have made a million dollars in Citi stocks, provided you had 27 million dollars in April last year. If it is any comfort, the slide continues in other countries too, some of them faring far worse than the United States.

I was struck by the precipitous decline of the Indian Rupee against the Dollar as foreign investors have started pulling money out from India. I previously wrote about the speculation caused by the rising rupee. It looks like the party is over now, though it might take many people time to realize this. This is the first time many young Indian adults are seeing the effects of a bad economy, such as layoffs from previously stable technology companies.

In 2003, Iceland’s three biggest banks had assets of only a few billion dollars, about 100 percent of its gross domestic product. Over the next three and a half years they grew to over $140 billion and were so much greater than Iceland’s G.D.P. that it made no sense to calculate the percentage of it they accounted for. […]

From 2003 to 2007, while the U.S. stock market was doubling, the Icelandic stock market multiplied by nine times. Reykjavík real-estate prices tripled. By 2006 the average Icelandic family was three times as wealthy as it had been in 2003 […]

When their three brand-new global-size banks collapsed, last October, Iceland’s 300,000 citizens found that they bore some kind of responsibility for $100 billion of banking losses—which works out to roughly $330,000 for every Icelandic man, woman, and child. On top of that they had tens of billions of dollars in personal losses from their own bizarre private foreign-currency speculations, and even more from the 85 percent collapse in the Icelandic stock market. The exact dollar amount of Iceland’s financial hole was essentially unknowable, as it depended on the value of the generally stable Icelandic krona, which had also crashed and was removed from the market by the Icelandic government. […]

Now many Icelanders—especially young Icelanders—own $500,000 houses with $1.5 million mortgages, and $35,000 Range Rovers with $100,000 in loans against them.

As the article says, “Iceland instantly became the only nation on earth that Americans could point to and say, ‘Well, at least we didn’t do that.’” Writing about this may seem like schadenfreude, but the state of affairs today is truly tragic for people across the globe. Recent globalization had helped in pulling hundreds of millions of people out of poverty in China and India. This economic slowdown will set back poverty reduction by several years. And the economic crisis will throw millions out of their jobs and houses.

When and if the bottom of this crisis is reached, countries will have to focus on some basics. Most of the growth that we saw in the last decade was a result of bubbles in the financial and real estate sectors. Think about this: When the price of milk or oil increases, we call it inflation and treat it as something to be stopped. Yet when the prices of stocks and houses increased without any relationship to real incomes and underlying financials, it was labeled “growth” and encouraged by politicians, bankers and investors.

We have to get back to fundamentals where price is related to value and not financial gimmicks. Steady, dependable growth is preferable to sudden bursts of wealth followed by mass destruction. Because of the hype caused by rising house prices, millions of people have lost their life savings and are deep in debt from which they will take years to crawl out of. Let’s hope, as a society, we can collectively remember these bad times and prevent them in the future.

Every correction is the same, a normal downturn in one or more of the markets where we invest. There has never been a correction that has not proven to be an investment opportunity. You can be confident that governments around the world are not going to allow another Great Depression "on their watch".

Every correction is different, the result of various economic and/or political circumstances that create the need for adjustments in the financial markets. While everything is down in price, as it is now, there is actually less to worry about. When the going gets tough, the tough go shopping.

In this case, an overheated real estate market, an overdose of financial bad judgment, and a damn the torpedoes stock market, propelled by demand for speculative derivative securities and Hedge Funds, finally came unglued.

But it is the reality of corrections that is one of the few certainties of the financial world, one that separates the men from the boys, if you will. If you fixate on your portfolio market value during a correction, you will just give yourself a headache, or worse.

Few of the fundamental qualities that made your IGVSI securities sound investments just two years ago have permanently disappeared. We'll be using credit cards, driving cars and motorcycles, drinking beer, and buying clothes twenty years from now. Very few interest payments have been missed and surprisingly few dividends eliminated.

Only the prices have changed, to preserve the long-term reality of things---and in both of our markets.

Corrections are beautiful things, but having two of them going on at the same time is like a trip to Fantasy Land. Theoretically, even technically I'm told, corrections adjust prices to their actual value or "support levels". In reality, it's much easier than that. Prices go down because of speculator reactions to expectations of news, speculator reactions to actual news, and investor profit taking.

The two "becauses" are more potent than ever because there is more self-directed money than ever. And therein lies the core of correctional beauty. Mutual Fund unit holders rarely take profits but rush to take losses. Additionally, the new breed of unregulated index-fund speculations is capable of producing a constant diet of volatility overload. New investment opportunities are everywhere.

Here's a list of ten things to think about or to do during corrections:

1. Don't beat yourself up by looking at your market value. You don't live in a vacuum and you should expect lower valuations. That is why you should only buy the highest quality securities in the first place and stick with a well-defined asset allocation plan. Look for ways to add to your portfolios.

2. Take a look at the past. There has never been a correction that has not proven to be a buying opportunity, in spite of the media hype that this one is somehow special. When they are broad, long, and deep, the rally that follows is normally broad, long, and steep. Get ready to party.

3. The "Smart Cash" produced by interest and dividends should be placed in new stocks for rapid profitable turnover--- don't be shy when you're looking at 50% discounts from recent highs. Buying too soon, in the right portfolio percentage, is nearly as important to long-term investment success as selling too soon is during rallies.

4. Take a look at the future. Nope, you can't tell when the rally will come or how long it will last. If you are buying quality securities now, as you certainly should be, you will be able to love the rally even more than you did the last time--- as you take yet another round of profits.

5. Buy more quickly in a prolonged correction, but establish new positions incompletely so that you can add to them safely later. There's more to "Shop at the Gap" than meets the eye, and you should remain confidently fully-invested at least until the media starts whispering: "rally".

6. Cash flow is king. Take smaller profits sooner than usual as long as there are abundant buying opportunities. Today, nearly sixty percent of all Investment Grade Value Stocks are down more than 25% from their 52-week highs. As long your cash flow continues unabated, change in market value is just a perceptual issue.

7. Note that your Working Capital is growing, in spite of fallen market prices, and examine your holdings for opportunities to average down and increase your yield on fixed income securities. Examine both fundamentals and price, lean hard on your experience, and don't force the issue.

8. Identify new buying opportunities using a consistent set of rules, be it rally or correction. That way you will always know which of the two you are dealing with in spite of the Wall Street propaganda. Focus on Investment Grade Value Stocks; it's easier, less risky, and better for your peace of mind.

10. So long as everything is down, there is little to worry about long term. Downgraded, or simply lazy, portfolio holdings should not be discarded during general or group specific weakness--- unless you don't have the courage to get rid of them during rallies.

Corrections of all types will vary in depth and duration, and both characteristics are clearly visible only in institutional-grade rear view mirrors. The short and deep ones are most lovable; the long and slow ones are more difficult to deal with.

Most corrections are relatively short and difficult to take advantage of with mutual funds. So if you over-think the environment or over-cook the research, you'll miss the after-party. Unlike many things in life, Stock Market realities need to be dealt with quickly, decisively, and with zero hindsight.

Amid all of the uncertainty, there is one indisputable fact that reads equally well in either market direction: there has never been a correction-rally that has not succumbed to the next rally-correction.

Steve Selenguthttp://www.sancoservices.comProfessional Portfolio Management since 1979Author of The Brainwashing of the American Investor and A Millionaire's Secret Investment Strategy